Is It Time for Tech?

It's been seven years since tech was king. Should we scratch the itch to buy?
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The equity markets have been hot, and so is the debate on whether they'll continue their streak. Yet the tech sector, a historic leader, has advanced only gradually. The Nasdaq and its biggest names like Intel (INTC) - Get Report, Cisco (CSCO) - Get Report and Sun Microsystems (SUNW) - Get Report remain at a small fraction of their former levels.

So you might be wondering -- when so many sectors are hitting all-time highs -- is this the time to buy? Let's examine.

To start with, why is now different? Has the business environment changed? Have the companies themselves really adapted? Here's what feels good:

  • Business cycle. As the overbought consumer curtails spending, textbook business cycle models suggest strong business investment comes next. Businesses, flush with cash and recovering from capacity shortages, spend on infrastructure -- and that means tech.
  • Discipline and maturity. Tech companies are being run by more mature management teams. They're real businesses, not just ideas.
  • New beneficiaries. Technology and especially information technologies have revolutionized business and government processes. But green fields -- like health care management -- still remain.
  • Weak dollar. Most technology bellwethers are U.S. companies. The dollar is down some 11 percent this year, making tech products that much cheaper for foreign buyers.
  • Low commodity price exposure. Most tech companies don't buy a lot of raw materials. And some may benefit as technology is substituted for energy-intensive activities, like commuting and business travel.

But like the aftereffects of a bad cold, the negatives still linger:

  • Short product life cycles. Short life cycles have dogged tech for years. Many tech products last less than a year in the marketplace, yet increased product complexity brings longer development cycles. The two forces don't mix well.
  • Low gross margins. Short life cycles and intense competition have cut margins to the bone. Dell recently reported a small rise in gross margin (revenue less direct cost to produce) to just over 17%. But who would want to buy a business that generated such low margins, or for that matter, operating margins of 6%? The stock was up $2 on the news, but I'm not sure why.
  • Overcapitalization. Some tech companies have huge capitalization and share counts. We see high price-to-sales ratios in bellwethers like Cisco (5.4) and Apple (4.8) -- anything over 3 is high. Cisco has 6 billion shares outstanding. A penny-per-share profit gain, or $60 million total, requires a $272 million sales increase even with their relatively strong 22% net profit margin. That's a lot of new sales.
  • Business cycle uncertainty. Business cycles are becoming shorter and less predictable. Who's to say that businesses will invest? Who can predict how much or what kind of "tech" gear they'll buy?

The technology space is enormous. There are more than 30 recognized sectors within the technology industry, including information technology, communications, health care, semiconductors, software and others.

So it isn't easy to generalize, except to say that you should look at technology investing just like any other kind of investing. Value -- and value investing principles -- rules. So I look for the following in all companies I invest in, and especially in the tech space:

  • Brand. A solid brand is indispensable. Good brands bring customer loyalty, thus higher prices and smoother product cycles, thus greater profits.
  • Moat. Good tech companies have sustainable competitive advantages in brand, product, or distribution channels. Sustainable is the key word.
  • Cash generation. Like all good businesses, good tech companies produce more capital than they consume. Look for positive cash flow and especially free cash flow beyond capital investment needs.
  • Strong export markets. As the world economies grow, companies with strong international markets will fare best.

Good value investors don't hang the "value" tag on a business just because the price is attractive. It must be a good business. It must be a business you'd want to be in, and want to be in more than any other.

I don't see many tech stocks today making the cut, but I'll suggest a few: applications software firms

Adobe Systems

(ADBE) - Get Report

and

Intuit

(INTU) - Get Report

; specialty semiconductor maker

Nvidia

(NVDA) - Get Report

; and, although not all parts of the business fit,

Hewlett-Packard

(HPQ) - Get Report

.

Click here for the video version of this story from Jennifer Openshaw.

Jennifer Openshaw, a passionate advocate for helping Americans improve their finances and build their personal fortunes, is CEO of

The Millionaire Zone and America Online's personal finance editor. In addition to appearing regularly on TV shows such as "Oprah" and "Good Morning America" and on CNN, Openshaw is host of ABC Radio's "Winning Advice" and serves as an adviser to some of America's top corporations. Her new book,

"The Millionaire Zone," will hit bookstores in April 2007.